The low interest rate, low volatility paradigm that rejuvenated the continent’s bond markets in the first half of 2014 was indeed followed by an increase in volatility that many perceived to be a temporary hitch in the recovery of the capital markets. That volatility has lasted, and in some cases, it may signal a real change of heart among investors who have been subject to six months of uncertainties and navel gazing.
But for the most part, brief episodes of chaos have been met with a measure of nonchalance (by those watching from the sidelines). Rates in Europe will remain low, onlookers say, and divergence in monetary policy between the eurozone and the US will isolate the bond markets on this side of the Atlantic from any capital markets tidal waves originating in the States. 2015 will have its bumps, but the overall dynamic and appetite for bonds will be the same, according to this argument.
One senior banker at a global bank said recently that, with no major and potentially market derailing events like the Asset Quality Review and the Scottish referendum next year, volatility is likely to remain low in 2015.
Of course, it isn't really the foreseeable sources of volatility investors need to worry about. The downfall of Banco Espírito Santo had a more insidious effect on investor sentiment than the approach and results of the Asset Quality Review did, though the actual restructuring of BES did relatively little damage.
Foreseeable hitches
That is not to say that investors even do efficiently position themselves against foreseeable hitches, especially in a distorted market environment where ‘bad’ is often ‘good’.
Remember Greece? Its glorious return to the bond markets in April allowed it to price a five year bond at a 4.75% yield. The bond traded at a high of 103.99 on September 5. In the weeks since December 10, when the bond traded above 102, it has fallen to below 83.
Many cite Greece’s decision to call snap elections in December, at a time when far left and euroskeptic party Syriza is ahead in polls, as the main cause of the sell-off. But Syriza has been gaining in the polls with almost the kind of intrepid consistency one might have noted in the Greek bond's steady rise in value.
The party’s win in EU elections in May caused a temporary dip in the bond’s price. As did the viral shock of the failure of one of Portugal’s largest banks over summer, and the announcement by Greece’s prime minister that the country would seek an early exit from the International Monetary Fund’s bailout loans – the existence of which was surely a key driver of some investment theses in the Greek bond.
This selloff is much more intense. But Greece had already had an election scheduled for February 2015. Why should pushing it two months forward make any difference? Especially as 2014 saw no significant weakening in Syriza’s traction with voters?
It seems there is some mispricing of risk, which won’t surprise some onlookers, given the truer and less attractive dynamic that led to Greece being able to access the market in the first place: the search for yield (as opposed to the ‘Greek recovery’).
Market participants are saying next year is likely to be more volatile, but in the same breath, that the general trend, in Europe at least, will remain the same: credit will remain a focus for hungry investors, who may hold off temporarily when volatility spikes.
Just a bit of bad weather?
But that is to assume that any coming storms will be just a bit of bad weather similar to what we’ve seen in the past. It very well might be otherwise, given potentially paradigm-shifting geopolitical risks are ongoing and we are long into an unprecedented era in global monetary policy.
Having never seen what kind of damage the coming storm could do, perhaps unable even to imagine, investors risk running full throttle into it. The engine driving that stubbornness is the fact that institutional investors have to make returns for their clients, regardless of the completeness of the information they have.
It is all has the potential to be a bit like Joseph Conrad’s Captain MacWhirr, who, against the advice of a plunging barometer and a savvy first mate, sails directly into a typhoon. Rational and unimaginative, he feels that having never experienced the damage a typhoon can do, he cannot justify to his employers losing good time and money by avoiding it:
“But suppose I went swinging off my course and came in two days late, and they asked me: 'Where have you been all that time, Captain?' What could I say to that? 'Went around to dodge the bad weather,' I would say. 'It must've been dam' bad,' they would say. 'Don't know,' I would have to say; 'I've dodged clear of it.'"